China Strength Buoying the Coal Sector

A good time to sell puts in the Market Vectors Coal ETF

Since highlighting the bullish reversal of fortune in China last month, the iShares FTSE/Xinhua China 25 (NYSE:FXI) has continued powering higher. In fact, the FXI is up over 4.5%, while the S&P 500 Index is down 0.3% since Oct. 11. Of course, owners of FXI aren’t the only beneficiaries of the newfound strength in China. Since the country is part and parcel of the emerging-market complex, a bullish party in the land of the dragon inevitably spills into other areas, like basic materials, that are tied to global growth.

One industry within the basic material space that’s finally showing signs of bottoming is coal. The Market Vectors Coal ETF (NYSE:KOL) spent much of the past year relegated to the dustbin of underperformance. Since its 2011 peak at $49.87, KOL plummeted as low as $21.49 in September — a harrowing drop of 56%. Fortunately, coal bulls (if any were left) have received a bit of a reprieve in recent months. After hammering out that new 52-week low in September, KOL has established a series of higher pivot highs and higher pivot lows.

Click to EnlargeWhat’s more, the basing action over the past few months has come in the form of an inverted head and shoulders pattern, which reveals a subtle shift in momentum from the bears to the bulls. A high-volume breakout of neckline resistance at $26 would both confirm and complete the pattern. Tack on the fact that KOL is now outperforming the broader market as implied by the rising comparative relative strength line in the chart, and you could make a fairly compelling case that bullish plays are worth a look in coal.

In light of KOL’s cheap price tag, I like the idea of selling puts to establish a high-probability position that will profit even if KOL treads water in the coming weeks. Traders could sell the November 25 put for 50 cents. The max reward is limited to the initial $50 (50 cents x 100) received at trade inception and will be captured provided KOL sits above $25 at November expiration.

To minimize the risk, you could close the position if KOL falls beneath $24. Those in search of more confirmation might consider waiting until KOL successfully breaks $26 before entering the position.